Bond ETFs And Taxes

Includes: AGG, EDV
by: Tom Lydon

Tax efficiency has been a major selling point for exchange traded funds, but experts believe volatility through the year may inflict some surprising ETF tax consequences.

Relatively safe bond ETFs have attracted more than $32 billion in assets year-to-date, compared to $26 billion for all of 2010, reports Elizabeth O’Brien for The Wall Street Journal.

Investing pros believe that while the heightened volatility contributed to large gains in many bonds, especially in Treasuries, ETF fund managers had to rebalance fund portfolios to match their target strategies, which may trigger capital gains.

“Investors could be caught off guard,” Jim Lowell, chief investment officer of Adviser Investments, said in the article.

BlackRock’s iShares revealed that its iShares Barclays Aggregate Bond (NYSEARCA:AGG) will distribute capital gains this year, WSJ reported. Vanguard also stated that 10 of its bond ETFs plan to distribute capital gains, with the largest coming out of the Vanguard Extended Duration Treasury Idx ETF (NYSEARCA:EDV). Additionally, PIMCO announced 17 of its ETFs will make distributions.

Nevertheless, ETFs are still very tax efficient. According to Morningstar, less than 10% of all ETFs issued capital gains in 2010. BlackRock has also been boasting that 99% of iShares ETFs will not distribute gains this year, and it’s a noteworthy accomplishment on delivering on the tax promise of ETFs.

Investment advisors have told clients to hold bond ETFs in individual retirement accounts and 401(k) plans to avoid potential capital gains.

Fund companies usually distribute capital gains in December.

Max Chen contributed to this article.